Why the Fed’s economic projections became more optimistic

The staff made some adjustments to the economic forecast from the October FOMC meeting

The staff economists took up their near-term estimate of GDP growth based on stronger retail sales despite the government shutdown. In many ways, the expected drag on the economy from the shutdown and the sequester never seemed to materialize. The staff is forecasting that GDP would accelerate going forward and some of the excess slack in the economy would be taken up.

As has been the case for this entire recession, capital expenditures and hiring remain sticking points, and business seems loath to do it until absolutely forced to. At this stage of the game, the fear for management still seems to be the dread of having too high a cost structure—not the fear of missing out on sales. That psychology has been firmly in place since 2008.

Participants viewed the effects of the shutdown as “temporary and limited,” a view that has been borne out by some stronger-than-expected data, particularly the October jobs report and the retail sales report released this morning. They mention that fiscal policy has been exerting significant restraint on economic growth, which fails to take into account that government spending as a percentage of GDP is well above post-WWII levels by a few percentage points and that five of the seven biggest postwar deficits as a percentage of GDP have been over the past five years. In other words, while fiscal accommodation is lower than a year or two ago, it’s still highly loose. It’s ironic that the Fed frets about market participants interpreting a decrease in asset purchases as “tightening” when it’s doing the same thing about fiscal policy.

On the labor market, it notes that the unemployment rate is dropping in the context of a lower labor force participation rate and discusses what that drop ultimately means. If workers are exiting the workforce due to retirement, that’s a different situation than workers leaving the workforce because they can’t find jobs. It notes a secular (long-term) decline in labor market dynamism or turnover, which is limiting wage gains (most people have to find a new job to get a raise—getting one from your current boss is difficult).